Regulation MC Questions With Solutions

Following are multiple choice questions recently released by the AICPA. These questions were released by the AICPA with letter answers only. Our editorial board has provided the accompanying explanations.

Please note that the AICPA generally releases questions that it does NOT intend to use again. These questions and content may or may not be representative of questions you may see on any upcoming exams.

2007 AICPA Newly Released Questions – Regulation

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1. CPA-05515 The Securities Act of 1933 provides an exemption from registration for: Bonds issued by Securities issued a municipality by a not-for-profit for governmental charitable purposes organization a. Yes Yes b. Yes No c. No Yes d. No No ANSWER: Choice "a" is correct. The 1933 Act generally requires issuances of securities to be registered unless a securities or transaction exemption applies. The 1933 Act includes a securities exemption for bonds issued by a municipality for governmental purposes and securities issued by a not-for-profit charitable organization.

Choice "b" is incorrect. The 1933 Act includes an exemption for not-for-profit charitable organizations.

Choice "c" is incorrect. The 1933 Act includes an exemption for bonds issued by a municipality for governmental purposes.

Choice "d" is incorrect. The 1933 Act generally requires issuances of securities to be registered unless a securities or transaction exemption applies. The 1933 Act includes a securities exemption for bonds issued by a municipality for governmental purposes and securities issued by a not-for-profit charitable organization.


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2. CPA-05516 Wilson, CPA, uses a commercial tax software package to prepare clients' individual income tax returns. Upon reviewing a client's computer-generated year 1 itemized deductions, Wilson discovers that the schedule's deductible investment interest expense is less than the amount paid by the taxpayer and the amount that Wilson entered into the computer. After analyzing the entire tax return, Wilson determines that the computer-generated investment interest expense deduction is correct. Why is the computer-generated investment interest expense deduction correct? I. The client's investment interest expense exceeds net investment income. II. The client's qualified residence interest expense reduces the deductible amount of investment interest

expense.

a. I only. b. II only. c. Both I and II. d. Neither I nor II. ANSWER: Choice "a" is correct. The computer-generated investment interest expense deduction will be limited to the net investment income of the taxpayer. Any excess amount will be carried forward indefinitely. For example, assume the taxpayer had $5,000 of investment interest for a year but had investment income of only $3,000. The tax preparer would enter the $5,000 paid as investment interest, and the computer would then allow only a $3,000 deduction for investment interest in the year. The remaining $2,000 of expense would be carried forward indefinitely to be applied to investment income in future years. Qualified residence interest is NOT investment interest and would not affect investment interest income in any manner.

Choices "b", "c", and "d" are incorrect, per the above discussion.


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3. CPA-05517 Which of the following requirements must be met, by any type of deed, in order for title to real property to be transferred? a. The deed must be delivered to the purchaser of the property. b. The deed must be recorded by the seller of the property. c. The deed must include a statement of the property's value. d. The deed must include a general warranty of title. ANSWER: Choice "a" is correct. To be effective, a deed must be in a writing signed by the grantor, it must describe the premises, and it must be delivered. Thus, choice "a" is correct.

Choice "b" is incorrect. Recording fixes the rights of the grantee against all third parties by giving them constructive notice of the grant; it is not required to make a deed effective between the grantor and grantee.

Choice "c" is incorrect. To be effective, a deed must be in a writing signed by the grantor, it must describe the premises, and it must be delivered. It need not include a statement of the property's value.

Choice "d" is incorrect. To be effective, a deed must be in a writing signed by the grantor, it must describe the premises, and it must be delivered. A deed may include a general warranty (i.e., a general warranty deed) but it need not include any warranty at all (i.e., a bargain and sale deed).


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4. CPA-05518 Walker transferred property used in a sole proprietorship to the WXYZ partnership in exchange for a one-fourth interest. The property had an original cost of $75,000, an adjusted tax basis to Walker of $20,000, and fair market value of $50,000. The partnership has no liabilities. What is Walker's basis in the partnership interest? a. $0 b. $20,000 c. $50,000 d. $75,000 ANSWER: Choice "b" is correct. Generally, no gain or loss is recognized on a contribution of property to a partnership in return for a partnership interest. The partner's original basis for a partnership interest acquired by contribution of property is the adjusted tax basis of the property (unless the property is subject to excess liability, which is not the case in this question).

Choice "a" is incorrect. Walker's adjusted tax basis in the property is $20,000. There are no partnership liabilities, and the facts do not indicate that the property was subject to excess liability. The facts in the question do not support a zero basis in the partnership interest.

Choice "c" is incorrect. The $50,000 fair market value is not used to determine the initial basis in the partnership interest; however, upon the sale of the property, the fair market value will be used in the calculation of the special allocation to the contributing partner of the built-in gain on the sale.

Choice "d" is incorrect. The $75,000 original cost of the property is not used to determine the contributing partner's basis. The amount to use is the adjusted tax basis (cost less depreciation or other basis reduction) upon contribution.


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5. CPA-05519 Olson, Wayne, and Hogan are equal partners in the OWH partnership. Olson's basis in the partnership interest is $70,000. Olson receives a liquidating distribution of $10,000 cash and land with a fair market value of $63,000, and a basis of $58,000. What is Olson's basis in the land? a. $58,000 b. $60,000 c. $63,000 d. $70,000 ANSWER: Choice "b" is correct.

In a liquidating distribution, the partner's basis for the distributed property is the same as the adjusted basis of his partnership interest (as the partner is simply exchanging his partnership interest for the distributed assets), reduced by any monies received in the same transaction.

Olson's basis before distribution $70,000 Less: Cash received (10,000) Remaining basis in partnership 60,000 Less: Allocate basis to land (60,000) Liquidated partnership basis $ 0

Choice "a" is incorrect. This would be the answer if the distribution were a non-liquidating distribution (which would then mean that partner would still have a partnership interest with a basis of $2,000 ($60,000 - $58,000 land basis).

Choice "c" is incorrect. The fair market value of the asset is not considered in a liquidation.

Choice "d" is incorrect. The allocable basis must first be reduced by the amount of cash received.


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6. CPA-05520 Cassidy, an individual, reported the following items of income and expense during the current year:

Salary $50,000 Alimony paid to a former spouse 10,000 Inheritance from a grandparent 25,000 Proceeds of a lawsuit for physical injuries 50,000

What is the amount of Cassidy's adjusted gross income? a. $40,000 b. $50,000 c. $115,000 d. $125,000 ANSWER: Choice "a" is correct. Gross income includes salary, but it excludes inheritance and proceeds from a lawsuit for physical injuries. Alimony paid is an adjustment from gross income to arrive at Adjusted Gross Income, as follows:

Gross Income: Salary $50,000 Inheritance 0 Proceeds from physical injury lawsuit 0

Adjustments: Alimony paid (10,000)

Adjusted gross income $40,000

Choice "b" is incorrect. Although salary is the only item of taxable gross income on the list, alimony is an allowable adjustment to arrive at adjusted gross income.

Choice "c" is incorrect. This answer choice includes all items of income given and deducts the alimony paid. Inheritance and proceeds from a lawsuit for physical injuries are NOT items of taxable gross income.

Choice "d" is incorrect. This answer choice includes all items of income given and does not deduct the alimony paid. Inheritance and proceeds from a lawsuit for physical injuries are NOT items of taxable gross income, and alimony IS an allowable deduction from gross income.


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7. CPA-05521 Taylor owns 1,000 shares of Media Corporation common stock with a basis of $22,000 and a fair market value of $33,000. Media paid a nontaxable 10% common stock dividend. What is the basis for each share of Media common stock owned by Taylor after receipt of the dividend? a. $20 b. $22 c. $30 d. $33 ANSWER: Choice "a" is correct. A stock dividend is a distribution by a corporation of its own stock to its shareholders. Stock dividends are generally not taxable unless the shareholder has a choice of receiving cash or other property, and the facts indicate that this is a nontaxable 10% dividend. The basis of a nontaxable stock dividend, where old and new shares are identical, is determined by dividing the basis of the old stock by the number of new shares. The calculation is as follows:

Original basis of 1,000 shares $22,000 Divided by new # of shares [1000 * 1.1] / 1,100 shares Basis per share after 10% stock dividend $ 20.00/share

Choice "b" is incorrect. This choice divides the original basis of $22,000 by the old number of shares, without considering the 10% stock dividend. [$22,000 / 1,000 = $22/share]

Choice "c" is incorrect. This choice uses the fair market value rather than the proper basis as the allocation base for the stock, but it does use the proper (new) amount of shares after the stock dividend. [$33,000 / 1,100 shares = $30/share]

Choice "d" is incorrect. This answer choice uses the fair market value rather than the proper basis as the allocation base for the stock, and it also improperly uses the old number of shares, without considering the stock dividend. [$33,000 / 1,000 shares = $33/share]


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8. CPA-05522 Beta, a C corporation, reported the following items of income and expenses for the year:

Gross income $600,000 Dividend income from a 30% owned domestic corporation 100,000 Operating expenses 400,000

What is Beta's taxable income for the year? a. $200,000 b. $220,000 c. $230,000 d. $300,000 ANSWER: Choice "b" is correct. Corporate taxable income is calculated as follows for a corporation:

Gross income $600,000 Dividend income 100,000** Operating expenses (400,000) Dividends received deduction (80,000) [80% DRD] Taxable income $220,000

** Note that the "gross income" amount for the calculation of taxable income should include dividend income; however, it does not appear that the $100,000 of dividends is included in the $600,000 gross income amount given. If it were, the answer options would be $100,000 less than they are.

Choice "a" is incorrect. The dividends received deduction allows for a special deduction of 80% of the dividends received from a 20% to <80% owned domestic corporation, not 100% of the dividends received (which applies only to ownership of 80% or more). [$600,000 + $100,000 - $400,000 - $100,000 DRD = $200,000]

Choice "c" is incorrect. The dividends received deduction allows for a special deduction of 80% of the dividends received from a 20% to <80% owned domestic corporation, not 70% of the dividends received (which applies only to ownership of 0% to <20%). [$600,000 + $100,000 - $400,000 - $70,000 DRD = $230,000]

Choice "d" is incorrect. This answer option does not include the special dividends received deduction [$600,000 + $100,000 - $400,000 - $0 DRD = $300,000].


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9. CPA-05523 Gibson purchased stock with a fair market value of $14,000 from Gibson's adult child for $12,000. The child's cost basis in the stock at the date of sale was $16,000. Gibson sold the same stock to an unrelated party for $18,000. What is Gibson's recognized gain from the sale? a. $0 b. $2,000 c. $4,000 d. $6,000 ANSWER: Choice "b" is correct. Losses are disallowed on most related party sales transactions even if they were made at an arm's length (FMV) price. The basis (and related gain or loss) of the (second) buying relative depends on whether the second relative's resale price is higher, lower, or between the first relative's basis and the lower selling price to the second relative. In this case, the $4,000 capital loss on the sale by Gibson's adult child to Gibson [$12,000 SP - $16,000 Basis] is disallowed. Gibson's basis is determined by his selling price to a third party. In this case, the selling price is $18,000, which is HIGHER than the original basis of Gibson's adult child. Gibson's basis in the stock is, therefore, his adult child's basis of $16,000. Gibson's recognized basis is calculated as follows:

Selling price $18,000 Basis (16,000) Gain $ 2,000

Choice "a" is incorrect. There would be a zero gain or loss if the selling price were between the adult child's basis and Gibson's purchase price, but this is not the case in the facts.

Choice "c" is incorrect. This answer option uses the fair market value of the stock at the date of purchase as the basis. As is discussed above, the rules do not provide for this treatment. [$18,000 SP - $14,000 FMV = $4,000]

Choice "d" is incorrect. This would be the answer if the basis were Gibson's purchase price of $12,000; however, because the stock sold for more than Gibson's child's basis and the child had a disallowed loss on the sale to Gibson, Gibson is allowed to use his child's original basis of $16,000 as his basis for the stock on the date of the second sale. [$18,000 SP - $12,000 PP = $6,000]


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10. CPA-05524 (Adapted) Which of the following is an attribute exclusively of a complex trust? a. It distributes income to more than one beneficiary. b. It has a grantor that is not an individual. c. It has a beneficiary that is not an individual. d. It distributes corpus. ANSWER: Choice "d" is correct. Complex trusts may accumulate current income, distribute principal, and provide for charitable contributions. Simple trusts may only make distributions from current income (not corpus, or principal), must distribute all income currently, and may not make charitable contributions. Either trust may have more than one beneficiary, have a grantor that is not an individual, or have beneficiaries that are not individuals.

Choice "a" is incorrect. Both complex and simple trusts may distribute income to more than one beneficiary.

Choice "b" is incorrect. Both complex and simple trusts may have a grantor that is not an individual.

Choice "c" is incorrect. Both complex and simple trusts may have a beneficiary that is not an individual.


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11. CPA-05525 Thorn purchased a used entertainment system from Sound Corp. The sales contract stated that the entertainment system was being sold "as is." Under the Sales Article of the UCC, which of the following statements is (are) correct regarding the seller's warranty of title and against infringement? I. Including the term "as is" in the sales contract is adequate communication that the seller is conveying

the entertainment system without warranty of title and against infringement. II. The seller's warranty of title and against infringement may be disclaimed at any time after the contract

is formed.

a. I only. b. II only. c. Both I and II. d. Neither I nor II. ANSWER: Choice "d" is correct. Under the Sales Article, all sales of goods include a warranty that the seller has title to the goods being sold unless the warranty is specifically disclaimed or the circumstances of the sale indicate that no such warranty is being made (e.g., a sheriff's sale). A disclaimer must be made before or contemporaneously with the sale. A later disclaimer would be ineffective. Thus, neither I nor II is correct.

Choices "a", "b", and "c" are incorrect, per the above.


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12. CPA-05526 Under the Negotiable Instruments Article of the UCC, which of the following instruments meets the negotiability requirement of being payable on demand or at a definite time? a. A promissory note payable one year after a person's marriage. b. A promissory note payable June 30, year 1, whose holder can extend the time of payment until the

following June 30 if the holder wishes. c. A promissory note payable June 30, year 1, whose maturity can be extended by the maker for a

reasonable time. d. An undated promissory note payable one month after date. ANSWER: Choice "b" is correct. An instrument is payable on demand if it says that it is payable on demand or is silent regarding the time for payment. An instrument is payable at a definite time only if the latest date on which payment can be made can be determined from the face of the instrument. An instrument payable on June 30 or the following June 30 if the holder wishes is payable at a definite time because the latest date on which payment is due can be determined from the face of the instrument (the following June 30).

Choice "a" is incorrect. An instrument is payable on demand if it says that it is payable on demand or is silent regarding the time for payment. An instrument is payable at a definite time only if the latest date on which payment can be made can be determined from the face of the instrument. The instrument here is not payable on demand. Neither is it payable at a definite time—even if the person's wedding date is set—because the wedding date could change.

Choice "c" is incorrect. An instrument is payable on demand if it says that it is payable on demand or is silent regarding the time for payment. An instrument is payable at a definite time only if the latest date on which payment can be made can be determined from the face of the instrument. The instrument is not payable on demand. Neither is it payable at a definite time because the extension clause does not set a specific due date.

Choice "d" is incorrect. An instrument is payable on demand if it says that it is payable on demand or is silent regarding the time for payment. An instrument is payable at a definite time only if the latest date on which payment can be made can be determined from the face of the instrument. The note is not payable on demand because it purports to be payable one month in the future. Neither is it payable at a definite time. Because the note is undated, it cannot be determined when the one-month period began or, consequently, when it ends.


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13. CPA-05527 Which of the following promises is supported by legally sufficient consideration and will be enforceable? a. A person's promise to pay a real estate agent $1,000 in return for the real estate agent's earlier act of

not charging commission for selling the person's house. b. A parent's promise to pay one child $500 because that child is not as wealthy as the child's sibling. c. A promise to pay the police $250 to catch a thief. d. A promise to pay a minor $500 to paint a garage. ANSWER: Choice "d" is correct. To constitute consideration, there must be a bargained for exchange of value. A detriment to the promisee or a benefit to the promisor constitutes value. A promise to pay a minor $500 to paint a garage constitutes a detriment to the promisee—the promisee is not otherwise bound to pay the minor $500 to paint the garage, and the minor's painting the garage constitutes valid consideration to support the promise to pay $500.

Choice "a" is incorrect. To constitute consideration, there must be a bargained for exchange of value. A detriment to the promisee or a benefit to the promisor constitutes value. Past acts generally do not constitute valid consideration because the acts were not bargained for. Thus, a promise to pay $1,000 in return for a prior performed act (not charging for services) is not supported by consideration.

Choice "b" is incorrect. To constitute consideration, there must be a bargained for exchange of value. A detriment to the promisee or a benefit to the promisor constitutes value. Here, there is no bargained for exchange. The promise is gratuitous and not supported by consideration.

Choice "c" is incorrect. To constitute consideration, there must be a bargained for exchange of value. A detriment to the promisee or a benefit to the promisor constitutes value. A promise to perform a pre-existing duty does not constitute valid consideration. Because a police officer already owes a crime victim a duty to catch the perpetrator, the police officer's promise to perform his duty does not constitute valid consideration.


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14. CPA-05528 Which of the following circumstances is a defense to an accountant's liability under Section 11 of the Securities Act of 1933 for misstatements and omissions of material facts contained in a registration statement? a. The absence of scienter on the part of the accountant. b. The absence of privity between purchasers and the accountant. c. Due diligence on the part of the accountant. d. Nonreliance by purchasers on the misstatements. ANSWER: Choice "c" is correct. To make out a case under Section 11, a plaintiff need only prove that the plaintiff acquired the stock, there was a material misstatement in a registration statement signed by the defendant, and damages. However, an accountant can avoid liability by raising the defense of due diligence.

Choice "a" is incorrect. To make out a case under Section 11, a plaintiff need only prove that the plaintiff acquired the stock, there was a material misstatement in a registration statement signed by the defendant, and damages. Because scienter is not an element of the cause of action, the absence of scienter is not a defense.

Choice "b" is incorrect. To make out a case under Section 11, a plaintiff need only prove that the plaintiff acquired the stock, there was a material misstatement in a registration statement signed by the defendant, and damages. Because privity is not required, the absence of privity is not a defense.

Choice "d" is incorrect. To make out a case under Section 11, a plaintiff need only prove that the plaintiff acquired the stock, there was a material misstatement in a registration statement signed by the defendant, and damages. Because reliance on the misstatement is not a requirement, the absence of reliance is not a defense.


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15. CPA-05529 How may taxes paid by an individual to a foreign country be treated? a. As an itemized deduction subject to the 2% floor. b. As a credit against federal income taxes due. c. As an adjustment to gross income. d. As a nondeductible. ANSWER: Choice "b" is correct. A taxpayer may claim a credit against federal income taxes due for foreign income taxes paid to a foreign country or a U.S. possession. There is a limitation on the amount of the credit an individual can obtain. In lieu of this credit, an individual might find it better to deduct the taxes as an itemized deduction (NOT subject to the 2% floor) instead. Note that the only correct response to this question is choice "b"; however, also note that the other option for treating the taxes paid to the foreign country is not included as an answer option.

Choice "a" is incorrect. Although taxes paid by an individual to a foreign country are allowable itemized deductions, they are NOT subject to the 2% floor.

Choice "c" is incorrect. An adjustment is not allowed for taxes paid by an individual to a foreign country. A taxpayer may claim a credit against federal income taxes due for foreign income taxes paid to a foreign country or a U.S. possession. In lieu of this credit, an individual might find it better to deduct the taxes as an itemized deduction (NOT subject to the 2% floor) instead.

Choice "d" is incorrect. A taxpayer may claim a credit against federal income taxes due for foreign income taxes paid to a foreign country or a U.S. possession. In lieu of this credit, an individual might find it better to deduct the taxes as an itemized deduction (NOT subject to the 2% floor) instead.


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16. CPA-05530 A C corporation must use the accrual method of accounting in which of the following circumstances? a. The business had average sales for the past three years of less than $1 million. b. The business is a service company and has over $1 million in sales. c. The business is a personal service business with over $15 million in sales. d. The business has more than $10 million in average sales. ANSWER: Choice "d" is correct. While the cash basis of accounting is used for tax purposes by most individuals, qualified personal service corporations (which are treated as individuals for purposes of these rules), and taxpayers whose average annual gross receipts do not exceed $1,000,000, the accrual basis method of accounting for tax purposes is required for the following:

● The accounting purchase and sales of inventory (and inventories must be maintained) ● Tax shelters ● Certain farming corporations (other farming or tree-raising businesses may generally use to the

cash basis) ● C Corporations, trusts with unrelated trade or business income, and partnerships having a C

corporations as a partner PROVIDED the business has GREATER than $5 million of average annual gross receipts for the three-year period ending with the prior tax year

Choice "a" is incorrect. A C corporation with average annual sales for the past three years of less than $1,000,000 would not be required to file income taxes using the accrual basis method of accounting, as generally, taxpayers whose annual average annual gross receipts do not exceed $1,000,000 are exempt from the requirement.

Choice "b" is incorrect. A service company with more than $1,000,000 in annual sales will generally not be required to file income taxes using the accrual basis of accounting because it likely has not met the test of $5 million in average annual gross receipts for the three-year period ending with the prior tax year. The facts do not disclose all relevant information; however, remember, the BEST answer is what we are looking for (and that is answer option "d").

Choice "c" is incorrect. Personal service corporations are treated as individuals for purposes of the rules for accrual basis tax reporting; therefore, personal service corporations (regardless of the amount of gross receipts), may use the cash basis of reporting for income tax purposes.


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17. CPA-05531 A corporation that has both preferred and common stock has a deficit in accumulated earnings and profits at the beginning of the year. The current earnings and profits are $25,000. The corporation makes a dividend distribution of $20,000 to the preferred shareholders and $10,000 to the common shareholders. How will the preferred and common shareholders report these distributions? a. Preferred - $20,000 dividend income; common - $10,000 dividend income. b. Preferred - $20,000 dividend income; common - $5,000 dividend income, $5,000 return of capital. c. Preferred - $15,000 dividend income; common - $10,000 dividend income. d. Preferred - $20,000 return of capital; common - $10,000 return of capital. ANSWER: Choice "b" is correct. A dividend to a preferred shareholder is based on that shareholder's fixed percentage at purchase. Preferred shareholders are not common equity owners of a corporation, and they only get paid based on their preferred percentage; therefore, any dividend payments to a preferred shareholder are considered dividend income to the preferred shareholder. Preferred shareholders are paid in full before common shareholders receive dividends.

Common shareholders are residual owners of a corporation and share in the retained earnings ("earnings and profits" is the tax term) of the corporation as well as the net assets. A "dividend" distribution to a common shareholder may or may not be classified as a taxable dividend. A dividend is defined by the Internal Revenue Code as a distribution of property by a corporation out of its earnings and profits (E & P). Dividends come first from current E&P and then from accumulated E&P. Any distributions in excess of current or accumulated E&P are first return of capital (up to the basis of the common stock) and then capital gain distribution.

In this case, the facts tell us that the company has a deficit in accumulated E&P as of the beginning of the year and that current E&P is $25,000. The facts do not tell us the amount of common shareholder capital in the corporation, but none of the answer choices provide for capital gain distributions, so we have to assume that the capital is in excess of the balance of the distribution after the current E&P is allocated. Because preferred shareholders are paid first, the $20,000 paid to them reduces available current E&P to distribute to $5,000 [$25,000 - $20,000]. The preferred shareholders are taxed on $20,000 of dividends. The common shareholders would report $5,000 in dividend income (the remaining amount of current E&P) and would have $5,000 in return of capital [$5,000 + $5,000 = $10,000 paid to the common shareholders].

Choice "a" is incorrect. Please refer to the discussion above for choice "b". $20,000 is taxable to the preferred stockholders as dividend income. However, there is not enough E&P to provide for $10,000 of dividend income to the common shareholders. After the preferred shareholders are paid their $20,000, only $5,000 of E&P is available for distribution as a taxable dividend. The balance of the common shareholder distribution ($5,000) is return of capital.

Choice "c" is incorrect. Please refer to the discussion above for choice "b". As mentioned, preferred shareholders are paid before common shareholders are paid. This answer choice incorrectly assumes that the common shareholders are allocated their $10,000 first as dividend income and the preferred shareholders receive the balance of E&P ($15,000) as dividend income.

Choice "d" is incorrect. Please refer to the discussion above for choice "b". The corporation has $25,000 of available E&P from which to distribute to the shareholders. Distributions are deemed to come from current E&P first and then from accumulated E&P (of which there is zero in this case). Only the excess is allocated to return of capital (to the extent of capital) and then to capital gain distribution, if excess remains.


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18. CPA-05532 Under which of the following circumstances may a CPA charge fees that are contingent upon finding a specific result? a. For an examination of prospective financial statements. b. For an audit or a review if agreed upon by both the CPA and the client. c. For a compilation if a third party will use the financial statement and disclosure is not made in the

report. d. If fixed by courts, other public authorities, or in tax matters if based on the results of judicial

proceedings. ANSWER: Choice "d" is correct. Fees are not regarded as being contingent when they are fixed by courts or other public authorities or in tax matters, if they are based on the results of court or the findings of governmental agencies. Further, contingent fees are permitted for compilations only if the member includes a statement that the member is not independent.

Choice "a" is incorrect. Contingent fees are specifically prohibited for audits and reviews of financial statements or examinations of prospective financial information.

Choice "b" is incorrect. Contingent fees are specifically prohibited for audits and reviews of financial statements or examinations of prospective financial information.

Choice "c" is incorrect. Contingent fees are permitted for compilations only if the member includes a statement that the member is not independent.


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19. CPA-05533 According to the ethical standards of the profession, a CPA's independence would most likely be impaired if the CPA: a. Accepted any gift from a client. b. Became a member of a trade association that is a client. c. Contracted with a client to supervise the client's office personnel. d. Served, with a client bank, as a co-fiduciary of an estate or trust. ANSWER: Choice "c" is correct. With regard to business relationships, independence is impaired if the member is an employee of an attestation client or is able to make management decisions on behalf of the client. Independence would, therefore, be impaired if a CPA contracted with the client to supervise the client's office personnel (e.g., in the performance of normal recurring activities).

Choice "a" is incorrect. Independence is impaired only by acceptance of more than a token gift. This answer choice indicates that ANY gift would impair independence.

Choice "b" is incorrect. Membership in a trade organization that is a client would not cause independence to be impaired unless the CPA served in a management capacity of the trade organization.

Choice "d" is incorrect. Independence is not impaired if a CPA serves as a co-trustee of an estate or trust with a client bank. The CPA is not making management decisions for the client in this case. The CPA is simply making management decisions for the estate or trust along with the client bank.


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20. CPA-05534 Martinsen, a calendar-year individual, files a year 1 tax return on March 31, year 2. Martinsen reports $20,000 of gross income. Martinsen inadvertently omits $500 interest income. The IRS may assess additional tax up until which of the following dates? a. March 31, year 5. b. April 15, year 5. c. March 31, year 8. d. April 15, year 8. ANSWER: Choice "b" is correct. Generally, the statute of limitations on assessments is three years from the later of the due date of the return or the date the return was filed (including amended returns). The IRS has up to six years to assess additional tax if the misstatement is an understatement of 25% or more of gross income. In this case, the misstatement is $500 on $20,000 of gross income, or 2.5%. Therefore, the statute of limitations for Martinsen is the general rule. In this case, the due date of the return was April 15, Year 2. Martinson filed on March 31, Year 2. Under the general rule, the IRS has until three years from April 15, Year 2 (or, April 15, Year 5) to assess additional tax.

Choice "a" is incorrect. In this case, the statute of limitations on assessments is three years from the later of the due date of the return or the date the return was filed (including amended returns). March 31 is the earlier of the two dates.

Choice "c" is incorrect. Please refer to the discussion for the correct choice "b". This answer choice is incorrect because it uses the earlier of the two dates and the improper number of six years as the statute of limitations.

Choice "d" is incorrect. Please refer to the discussion for the correct choice "b". This answer choice is incorrect because it uses the improper number of six years as the statute of limitations.


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21. CPA-05535 The at-risk limitation provisions of the Internal Revenue Code may limit: I. A partner's deduction for his or her distributive share of partnership losses. II. A partnership's net operating loss carryover.

a. I only. b. II only. c. Both I and II. d. Neither I nor II. ANSWER: Choice "a" is correct. A partner's tax deduction for his or her distributive share of partnership losses is limited to the partner's adjusted basis in the partnership, which is increased by any partnership liabilities that he or she is personally liable for (called the "at-risk" provision). Any unused loss can be carried forward and used in a future year when basis becomes available; therefore, the at-risk limitation does not limit a partner's net operating loss carryover.

Choices "b", "c", and "d" are incorrect, based on the above discussion.


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22. CPA-05536 On December 31, after receipt of his share of partnership income, Clark sold his interest in a limited partnership for $30,000 cash and relief of all liabilities. On that date, the adjusted basis of Clark's partnership interest was $40,000, consisting of his capital account of $15,000 and his share of the partnership liabilities of $25,000. The partnership has no unrealized receivables or substantially appreciated inventory. What is Clark's gain or loss on the sale of his partnership interest? a. Ordinary loss of $10,000. b. Ordinary gain of $15,000. c. Capital loss of $10,000. d. Capital gain of $15,000. ANSWER: Choice "d" is correct. A partner who sells his interest in a partnership has a recognized gain or loss that is measured by the difference between the amount realized for the sale and the adjusted basis of the partnership interest. If there are any partnership liabilities allocated to the interest and transferred to the buyer, they are considered part of the amount realized. Any gain that represents a partner's share of "hot assets" (unrealized receivables of appreciated inventory) is treated as ordinary income if cash is taken. Clark's capital gain on the sale is calculated as follows:

Amount realized on the sale:

Cash $30,000

Liabilities relieved of 25,000 $55,000

Less:

Basis in the partnership (40,000)

CAPITAL [Note *] gain on sale $15,000

* Note: The facts tell us that the partnership had no unrealized receivables or substantially appreciated inventory; therefore, there are no "hot assets" to cause Clark to categorize any of the gain as ordinary income. The entire gain is capital gain.

Choice "a" is incorrect. This answer option incorrectly excludes the partnership liabilities that Clark is relieved of as part of the amount realized [$30,000 cash received - $40,000 basis = $10,000 loss]. Further, as the partnership has no unrealized receivables or appreciated inventory, ordinary income recognition is not applicable.

Choice "b" is incorrect. This answer option correctly calculates the gain on the sale as $15,000, but it incorrectly categorizes the gain as ordinary, when there are no unrealized receivables or appreciated inventory items that would cause ordinary income recognition to be applicable.

Choice "c" is incorrect. This answer option incorrectly excludes the partnership liabilities that Clark is relieved of as part of the amount realized [$30,000 cash received - $40,000 basis = $10,000 loss]. However, the classification of the gain as capital is correct because the partnership has no unrealized receivables or appreciated inventory that would cause ordinary income recognition to be applicable.


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23. CPA-05537 Robert had current-year adjusted gross income of $100,000 and potential itemized deductions as follows:

Medical expenses (before percentage limitations) $12,000 State income taxes 4,000 Real estate taxes 3,500 Qualified housing and residence mortgage interest 10,000 Home equity mortgage interest (used to consolidate personal debts) 4,500 Charitable contributions (cash) 5,000

What are Robert's itemized deductions for alternative minimum tax? a. $17,000 b. $19,500 c. $21,500 d. $25,500 ANSWER: Choice "a" is correct. Robert's itemized deductions for alternative minimum tax purposes are calculated as follows:

Medical expenses (exceeding 10% of AGI) $2,000 State income taxes (not allowed) -- Real estate taxes (not allowed) -- Qualified housing and residence interest 10,000 Home equity mortgage interest (not used to buy,

build, or improve the home—not allowed) -- Charitable contributions (no difference) 5,000

Alternative Minimum Itemized deductions $17,000

Choices "b", "c", and "d" are incorrect, per the above calculation.


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24. CPA-05538 In the current year Jensen had the following items:

Salary $50,000 Inheritance 25,000 Alimony from ex-spouse 12,000 Child support from ex-spouse 9,000 Capital loss on investment stock sale (6,000)

What is Jensen's AGI for the current year? a. $44,000 b. $59,000 c. $62,000 d. $84,000 ANSWER: Choice "b" is correct. The question asks for AGI, but all of the items in the list are items of potential gross income. There are no adjustments included in the list; therefore, in this case, AGI is the same as gross income. The calculation is as follows:

Salary $50,000 Inheritance 0 [not taxable] Alimony from ex-spouse 12,000 Child support from ex-spouse 0 [not taxable] Capital loss on investment stock sale (3,000) [maximum deductible]

AGI $59,000

Choices "a", "c", and "d" are incorrect, per the above calculation.


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25. CPA-05539 Grill deals in the repair and sale of new and used clocks. West brought a clock to Grill to be repaired. One of Grill's clerks mistakenly sold West's clock to Hone, another customer. Under the Sales Article of the UCC, will West win a suit against Hone for the return of the clock? a. No, because the clerk was not aware that the clock belonged to West. b. No, because Grill is a merchant to whom goods had been entrusted. c. Yes, because Grill could not convey good title to the clock. d. Yes, because the clerk was negligent in selling the clock. ANSWER: Choice "b" is correct. Generally, a person cannot pass on better title than the person has. However, if the owner of goods entrusts them to a merchant who deals in goods of that kind, and the merchant sells them in the ordinary course of the merchant's business, then the merchant has the power to transfer title to the goods. West was the owner of the clock and he entrusted the clock to Grill, who deals in new and used clocks. Grill sold the clock to Hone in the ordinary course of business. Thus, Grill had the power to pass on good title to the clock and did so when one of Grill's clerks mistakenly sold the clock to Hone. Because Hone has title to the clock, West cannot recover it from Hone. However, West does have an action for damages against Grill.

Choice "a" is incorrect. Generally, a person cannot pass on better title than the person has. However, if the owner of goods entrusts them to a merchant who deals in goods of that kind, and the merchant sells them in the ordinary course of the merchant's business, then the merchant has the power to transfer title to the goods although "a" gives the correct result, it is irrelevant whether or not the clerk was aware that the clock belonged to West.

Choice "c" is incorrect. Generally, a person cannot pass on better title than the person has. However, if the owner of goods entrusts them to a merchant who deals in goods of that kind, and the merchant sells them in the ordinary course of the merchant's business, then the merchant has the power to transfer title to the goods thus, "c" is incorrect.

Choice "d" is incorrect. Generally, a person cannot pass on better title than the person has. However, if the owner of goods entrusts them to a merchant who deals in goods of that kind, and the merchant sells them in the ordinary course of the merchant's business, then the merchant has the power to transfer title to the goods It is irrelevant whether the clerk was negligent.


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26. CPA-05540 Reid, Welsh, and May are equal partners in the RWM partnership. Reid's basis in the partnership interest is $60,000. Reid receives a liquidating distribution of $61,000 cash and land with a fair market value of $14,000 and an adjusted basis of $12,000. What gain must Reid recognize upon the liquidation of his partnership interest? a. $0 b. $1,000 c. $13,000 d. $15,000 ANSWER: Choice "b" is correct. With a liquidating distribution, the partner's basis for the distributed property is the same as the adjusted basis of his partnership interest, first reduced by any monies received. The partner will recognize gain only to the extent that money received exceeds the partner's basis in the partnership.

Basis before liquidating distribution $60,000 Less: Cash received (61,000) Cash received in excess of basis (1,000) Gain to be recognized 1,000 Basis after gain recognition $ - 0 –

** NOTE: The basis of the land to Reid is zero, as Reid has no remaining basis in the partnership to allocate to the land (i.e., Reid has exchanged his entire interest in the partnership for the cash and the land).

Choice "a" is incorrect. Gain is recognized because the cash received exceeded the basis in the partnership before the liquidation.

Choice "c" is incorrect. This answer option incorrectly assumes that the adjusted basis of the land reduced the basis in the partnership before the cash received reduced the basis. As mentioned above, cash received must first reduce the basis before any allocation of basis can be made to the remaining non-cash property [$60,000 - $12,000 = $48,000; $48,000 - $61,000 = ($13,000) in excess of basis].

Choice "d" is incorrect. This answer option incorrectly assumes that the fair market value of the land (fair market value would not be used even if cash were not received, however) reduced the basis in the partnership before the cash received reduced the basis. As mentioned above, cash received must first reduce the basis before any allocation of basis can be made to the remaining non-cash property [$60,000 - $14,000 = $46,000; $46,000 - $61,000 = ($15,000) in excess of basis].


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27. CPA-05541 On April 1, Roe borrowed $100,000 from Jet to pay Roe's business expenses. On June 15, Roe gave Jet a signed security agreement and financing statement covering Roe's inventory. Jet immediately filed the financing statement. On July 1, Roe filed for bankruptcy. Under the federal Bankruptcy Code, can Roe's trustee in bankruptcy set aside Jet's security interest in Roe's inventory? a. Yes, because a security agreement may only cover goods actually purchased with the borrowed

funds. b. Yes, because Roe giving the security interest to Jet created a voidable preference. c. No, because the security interest was perfected before Roe filed for bankruptcy. d. No, because the loan proceeds were used for Roe's business. ANSWER: Choice "b" is correct. A trustee in bankruptcy has the power to set aside preferences, which generally may be defined as a transfer made for the benefit of a creditor on account of an antecedent debt made within 90 days of the filing of the bankruptcy petition while the debtor was insolvent (presumed within the 90-day period) that enables the creditor to get more than the creditor would have received in the bankruptcy proceeding. The giving of a security interest is included in the definition of a transfer.

Choice "a" is incorrect. A security interest can be taken in any of a debtor's property—there is no requirement that the goods covered be purchased with borrowed funds. However, a security interest in such goods does have a special name: a purchase money security interest.

Choice "c" is incorrect. Although the security interest was perfected through filing before the bankruptcy petition was filed, it nevertheless constitutes a preference because it was given on account of an antecedent debt within 90 days of the filing of the bankruptcy petition.

Choice "d" is incorrect. There is no such exemption under preference law. The security interest constitutes a preference because it was given on account of an antecedent debt within 90 days of the filing of the bankruptcy petition.


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28. CPA-05542 For which of the following contracts will a court generally grant the remedy of specific performance? a. A contract for the sale of a patent. b. A contract of employment. c. A contract for the sale of fungible goods. d. A contract for the sale of stock that is traded on a national stock exchange. ANSWER: Choice "a" is correct. Specific performance is a court order to perform under the terms of a contract. Generally, it is available only in contracts for unique or rare property. A patent, by definition, is unique. Therefore, specific performance would be available to enforce a contract for the sale of a patent.

Choice "b" is incorrect. Specific performance is not available to enforce a contract of employment—at least not in an action by the employer—because it would be tantamount to an order of involuntary servitude.

Choice "c" is incorrect. Specific performance is available only to enforce a contract involving unique or rare property. It is not available to enforce a contract for fungible goods, as such goods are easily replaced.

Choice "d" is incorrect. Specific performance is available only to enforce a contract involving unique or rare property. It is not available to enforce a contract for fungible items. Stock traded on a national securities exchange is fungible.


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29. CPA-05543 Evan, an individual, has a 40% interest in EF, an S corporation. At the beginning of the year, Evan's basis in EF was $2,000. During the year, EF distributed $100,000 and reported operating income of $200,000. What amount should Evan include in gross income? a. $38,000 b. $40,000 c. $80,000 d. $118,000 ANSWER: Choice "c" is correct. Like partnerships, S corporations report both separately and non-separately stated items of income and/or loss. Allocations to shareholders are made on a per-share, per-day basis in accordance with ownership percentage. Shareholders in an S corporation must include on their personal income tax return their distributive share of each separate "pass-through" item. Shareholders are taxed on these items, regardless of whether or not these items have been distributed to them during the year.

EF's operating income $200,000 Evan's ownership % 40% Gross income for Evan $ 80,000

Choice "a" is incorrect. This answer option incorrectly assumes that Evan's gross income is calculated as 40% of the distribution for the year ($100,000 x 40% = $40,000) less the basis of $2,000 as of the beginning of the year ($40,000 - $2,000 = $38,000).

Choice "b" is incorrect. This answer option incorrectly assumes that Evan's gross income is calculated as 40% of the distribution for the year ($100,000 x 40% = $40,000).

Choice "d" is incorrect. This answer option incorrectly assumes that Evan's gross income is 1 – 40%, or 60%, of the corporation's operating income for the year ($200,000 x 60% = $120,000), less the basis of $2,000 as of the beginning of the year ($120,000 - $2,000 = $118,000).


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30. CPA-05544 Brown transfers property to a trust. A local bank was named trustee. Brown retained no powers over the trust. The trust instrument provides that current income and $6,000 of principal must be distributed annually to the beneficiary. What type of trust was created? a. Simple. b. Grantor. c. Complex. d. Revocable. ANSWER: Choice "c" is correct. A complex trust may distribute principal, so this is the type of trust that was created.

Choice "a" is incorrect. A simple trust may not distribute principal, and the facts tell us that $6,000 of principal must be distributed annually to the beneficiary. Therefore, a simple trust could not have been created.

Choice "b" is incorrect. A grantor trust could not have been created, as it requires that a person transfer property to a trust and retain certain powers over the trust (or treat the trust as being owned by the transferor for income tax purposes). In this case, Brown does transfer property, but Brown retained no powers over the trust.

Choice "d" is incorrect. A revocable trust was not created because Brown retained no powers over the trust and, thus, no right to revoke it.


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31. CPA-05545 Under the Secured Transactions Article of the UCC, which of the following statements is (are) correct regarding the filing of a financing statement? I. A financing statement must be filed before attachment of the security interest can occur. II. Once filed, a financing statement is effective for an indefinite period of time provided continuation

statements are timely filed.

a. I only. b. II only. c. Both I and II. d. Neither I nor II. ANSWER: Choice "b" is correct. A financing statement relates to perfection of a security interest; it is not relevant to attachment. Thus, statement I is incorrect. Statement II, however, is correct. A financing statement is effective for five years, but can be extended for another five years by filing a continuation statement within six months of the end of the five year period. Successive continuation statements can be filed at the end of any five year period.

Choices "a", "c", and "d" are incorrect, per the above.


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32. CPA-05546 Under Section 12 of the Securities Exchange Act of 1934, in addition to companies whose securities are traded on a national exchange, what class of companies is subject to the SEC's continuous disclosure system? a. Companies with annual revenues in excess of $5 million and 300 or more shareholders. b. Companies with annual revenues in excess of $10 million and 500 or more shareholders. c. Companies with assets in excess of $5 million and 300 or more shareholders. d. Companies with assets in excess of $10 million and 500 or more shareholders. ANSWER: Choice "d" is correct. Under Section 12, companies must register (are subject to continuous disclosure requirements) if they are listed on a national securities exchange or they have at least 500 shareholders in any outstanding class and have at least $10 million in assets.

Choices "a", "b", and "c" are incorrect, per the above.


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33. CPA-05547 Magic Corp., a regular C corporation, elected S corporation status at the beginning of the current calendar year. It had an asset with a basis of $40,000 and a fair market value (FMV) of $85,000 on January 1. The asset was sold during the year for $95,000. Magic's corporate tax rate was 35%. What was Magic's tax liability as a result of the sale? a. $0 b. $3,500 c. $15,750 d. $19,250 ANSWER: Choice "c" is correct. A distribution or a sale of an S corporation's assets may result in a tax on any "built-in gain" at the corporate level. An unrealized "built-in gain" results when the following two conditions occur: (1) a C corporation elects S corporation status, and (2) the fair market value of the corporate assets exceeds the adjusted basis of corporate assets on the election date. The two conditions exist in the facts of the question. The net unrealized built-in gain is the excess of the fair market value of corporate assets over the adjusted basis of corporate assets at the beginning of the year in which the S corporation status is elected.

FMV at January 1 $85,000 Adjusted basis at January 1 (40,000) Excess 45,000 Times 35% tax rate 35% Corporate tax liability $15,750

Note: The gain to the corporation is a total of $55,000 ($95,000 - $40,000). An S corporation generally does not pay tax at the corporate level; however, in this case, there was built-in gain of $45,000 upon the election to become an S corporation, so the related C corporation tax must be paid upon the sale of the asset.

Choice "a" is incorrect. The gain to the corporation is a total of $55,000 ($95,000 - $40,000). An S corporation generally does not pay tax at the corporate level; however, in this case, there was built-in gain of $45,000 upon the election to become an S corporation, so the related C corporation tax must be paid upon the sale of the asset.

Choice "b" is incorrect. This answer option incorrectly assumes that the tax is calculated as 35% of the difference between the sales price of the asset ($95,000) and the fair market value at the effective date of the S election ($85,000). [$95,000 - $85,000 = $10,000; $10,000 * 35% = $3,500]

Choice "d" is incorrect. This answer option incorrectly uses the actual total gain on the sale (the sales price of $95,000 less the basis of $40,000) and then calculates the tax liability as 35% of that amount. [$95,000 - $40,000 = $55,000; $55,000 * 35% = $19,250]


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34. CPA-05548 Which of the following is subject to the Uniform Capitalization Rules of Code Sec. 263A? a. Editorial costs incurred by a freelance writer. b. Research and experimental expenditures. c. Mine development and exploration costs. d. Warehousing costs incurred by a manufacturing company with $12 million in annual gross receipts. ANSWER: Choice "d" is correct. Uniform capitalization rules apply to the following: (1) real or tangible personal property produced by the taxpayer for use in his or her trade or business; (2) real or tangible personal property produced by the taxpayer for sale to his or her customers; and (3) real or tangible personal property acquired by the taxpayer for resale, provided the taxpayer's annual average gross receipts for the preceding three years exceeds $10,000,000. Warehousing costs incurred by a manufacturing company (making inventory for sale to its customers) are subject to the Uniform Capitalization Rules. Further, they are the only item on the list that is real or tangible personal property. In this case, the inventory is not acquired for resale (it is produced by the taxpayer for sale to his or her customers), so the fact that the annual sales are $12,000,000 does not matter in this case. The sales could have been less than $10,000,000 annually, and the Uniform Capitalization Rules would still have applied.

Choices "a", "b", and "c" are incorrect, based on the above discussion.


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35. CPA-05549 Rock Crab, Inc. purchases the following assets during the year:

Computer $3,000 Computer desk 1,000 Office furniture 4,000 Delivery van 25,000

What should be reported as the cost basis for MACRS five-year property? a. $3,000 b. $25,000 c. $28,000 d. $33,000 ANSWER: Choice "c" is correct. MACRS 5-year property includes automobiles, light trucks, computers, typewriters, copiers, duplicating equipment, and other such items. The cost basis of the MACRS 5-year property is $28,000, calculated as follows:

Computer $ 3,000 Delivery van 25,000

MACRS 5-year $28,000

Choice "a" is incorrect. While the computer ($3,000) is included, the delivery van ($25,000) is also 5-year MACRS property.

Choice "b" is incorrect. While the delivery van ($25,000) is included, the computer ($3,000) is also MACRS 5-year property.

Choice "d" is incorrect. This answer option assumes that all of the assets in the question are MACRS 5-year property. However, the computer desk and the office furniture are MACRS 7-year property, which includes office furniture and fixtures, equipment and property with no ADR midpoint classified elsewhere, and railroad track.


36

36. CPA-05550 An individual had the following capital gains and losses for the year:

Short-term capital loss $70,000 Long-term gain (unrecaptured Section 1250 at 25%) 56,000 Collectibles gain (28% rate) 10,000 Long-term gain (15% rate) 20,000

What will be the net gain (loss) reported by the individual and at what applicable tax rate(s)? a. Long-term gain of $16,000 at the 15% rate. b. Short-term loss of $3,000 at the ordinary rate and long-term capital gain of $86,000 at the 15% rate. c. Long-term capital gain of $3,000 at the 15% rate, collectibles gain of $10,000 at the 28% rate, and

Section 1250 gain of $56,000 at the 25% rate. d. Short-term loss of $3,000 at the ordinary rate, long-term capital gain of $10,000 at the 15% rate,

collectibles gain of $10,000 at the 28% rate, and Section 1250 gain of $56,000 at the 25% rate. ANSWER: Choice "a" is correct. Specific netting procedures for capital gains and losses are outlined in the Internal Revenue Code for non-corporate taxpayers.

Gains and losses are netted within each tax rate group (e.g., the 15% rate group). The facts of this question have already performed this step for us.

Short-term Capital Gains and Losses

1. If there are any short-term capital losses (this includes any short-term capital loss carryovers), they are first offset against any short-term gains that would be taxable at the ordinary income rates.

2. Any remaining short-term capital loss is used to offset any long-term capital gains from the 28% grate group (e.g., collectibles).

3. Any remaining short-term capital loss is then used to offset any long-term gains from the 25% group (e.g., un-recaptured Section 1250 gains).

4. Any remaining short-term capital loss is used to offset any long-term capital gains applicable at the lower (e.g., 15%) tax rate.

Long-term Capital Gains and Losses

1. If there are any long-term capital losses (this includes any long-term capital loss carryovers) from the 28% rate group, they are first offset against any net gains from the 25% rate group and then against net gains from the 15% rate group.

2. If there are any long-term capital losses (this includes any long-term capital loss carryovers) from the 15% rate group, they are offset first against any net gains from the 28% rate group and then against net gains from the 25% rate group.

In this case, we are given net short-term capital losses of $70,000 to start with. Following the rules above, this first goes to offset any short-term gains at the ordinary income rates, but there are none in the facts. So, the next step is to offset the losses against any 28% rate gain long-term capital gains. The facts provide that there is $10,000 in gains from collectibles (taxable at the 28% rate). The remaining short-term loss ($60,000) is next used to offset the long-term capital gains at the 25% rate. The facts give us un-recaptured Section 1250 gains of $56,000 (taxed at the 25% tax rate). The remaining short-term capital loss is $4,000 ($70,000 - $10,000 - $56,000 = $4,000). The balance of the short-term capital losses is finally used to offset any capital gains taxed at the 15% tax rate, which the facts give us as $20,000. Therefore, after the $4,000 remaining short-term capital loss is applied to offset the $20,000 long-term capital gain taxed at the 15% tax rate, there is an amount of $16,000 remaining of long-term capital losses to be taxed at the 15% tax rate.

Choices "b", "c", and "d" are incorrect, per the ordering rules discussed above.


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37. CPA-05551 A CPA firm must do which of the following before it can participate in the preparation of an audit report of a company registered with the Securities and Exchange Commission (SEC)? a. Join the SEC Practice Section of the AICPA. b. Register with the Public Company Accounting Oversight Board. c. Register with the Financial Accounting Standards Board (FASB). d. Register with the SEC pursuant to the Securities Exchange Act of 1934. ANSWER: Choice "b" is correct. To participate in the preparation of audit reports, a CPA firm must register with the Public Company Accounting Oversight Board.

Choices "a", "c", and "d" are incorrect, per the above.


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38. CPA-05552 Under the uniform capitalization rules applicable to taxpayers with property acquired for resale, which of the following costs should be capitalized with respect to inventory if no exceptions have been met? Repackaging costs Off-site storage costs a. Yes Yes b. Yes No c. No Yes d. No No ANSWER: Choice "a" is correct. Direct material, direct labor, and factory overhead (applicable indirect costs) are capitalized with respect to inventory under the uniform capitalization rules for property acquired for resale. Applicable indirect costs include depreciation and amortization, insurance, supervisory wages, utilities, spoilage and scrap, design expenses, repair and maintenance and rental of equipment and facilities (including offsite storage), some administrative costs, costs of bonus and other incentive plans, and indirect supplies and other materials (including repackaging costs).

Choices "b", "c", and "d" are incorrect, per the above discussion.


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39. CPA-05553 Which of the following penalties is usually imposed against an accountant who, in the course of performing professional services, breaches contract duties owed to a client? a. Specific performance. b. Punitive damages. c. Money damages. d. Rescission. ANSWER: Choice "c" is correct. When a CPA breaches a contract for professional services, the client and any third party beneficiary of the contract is entitled to compensatory damages.

Choice "a" is incorrect. Generally, specific performance (an order to perform as agreed) is available only in a contract for the sale of rare or unique property. It is not available to enforce a personal services contract, as such an order would constitute an order for involuntary servitude.

Choice "b" is incorrect. Punitive damages are not available in a contract action.

Choice "d" is incorrect. Rescission is the cancellation of a contract. It is available after a breach, but usually the nonbreaching party will choose to recover its money damages instead of canceling.